More QE, yawn

The Bank of England has announced another £50bn of quantitative easing. This is less important than it seems.

The Bank’s own economists estimate that the first £200bn of QE raised real GDP by around 1.5 per cent. This implies that £50bn of QE might boost GDP by less than 0.4 per cent.

So, if you expected GDP to grow by around half a per cent this year without QE, you should now expect it to grow by less than one per cent. This does not change the big picture, that growth will be sluggish this year – weaker than in previous upturns, and probably not sufficient to stop unemployment rising.

In fact, I suspect even this is an over-estimate. One reason why the first round of QE worked was that it reduced tail risk – the perceived danger of a complete economic meltdown – and so put a floor under business confidence. But tail risk today is less of an issue; the problem is that the centre of the probability distribution of future outcomes is weak, rather than that the extreme of it is appalling.

But will QE be inflationary?

To some extent, it is meant to be. The Bank is undertaking QE precisely in order to raise inflation. It says: “the Committee judged that…without further monetary stimulus, it was more likely than not that inflation would undershoot the 2% target in the medium term.”

How inflationary it proves to be depends upon investors’ willingness to hold the extra cash. If they don’t want it, their efforts to dump it will lead to higher asset prices generally, and thus to increased business and consumer spending and hence to inflation.

Three things, however, suggest this effect won’t be large:

- £50bn is equivalent to just over three per cent of GDP. And our experience of the first round of QE suggests that this increased supply of money will to a large extent be matched by an increased demand for money. Bank economists estimate that the first £200bn of QE raised inflation by around 1.25 percentage points. If this £50bn injection has a proportionate impact, it’ll add about 0.3 percentage points to inflation.

- With investment opportunities constrained by the weak economy, investors who sell gilts will be content to hold close substitutes for gilts, such as cash. They were holding gilts in the first place because they were gloomy about the real economy, and QE on its own doesn’t much change things.

- The Bank of England might well reverse QE in coming years. Sir Mervyn King has said: “When we feel it's appropriate to tighten monetary policy, then selling those assets will be one mechanism by which we can tighten it.” The anticipation of this should, in theory, encourage investors to hold cash in the expectation that negative QE will depress asset prices. This anticipation, of course, dampens the stimulatory effect of today’s announcement.

Today’s announcement, then, is no big deal. It doesn’t much alter the fact that the economic outlook is pretty poor. And it certainly doesn’t put us on the road to massive inflation. Those who obsess about QE – for good and ill – are making the mistake of exaggerating the extent to which a £1.5 trillion economy can be turned around by policy measures.


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